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First-Timers Guide to Getting a Mortgage

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If you want to become a homeowner, chances are good you’ll need to apply for a mortgage one day. Fortunately, mortgages are financial products you don’t have to fear. Thanks to the plethora of lenders available and even federal mortgage programs, you may qualify for a low-cost, fixed rate mortgage that makes it easy to afford the home of your dreams.

How to Qualify for a Mortgage

But first, you need to know how to qualify. How do lenders decide whether you’re eligible — and ready — for a home loan of your own? Generally speaking, you need three main factors working in your favor to qualify for a home loan:

  • Good or great credit
  • A solid employment history
  • A down payment

Your Credit Score

According to credit reporting agency Experian, “very good” credit is any FICO score over 740. If your score falls into this category, you have a solid chance at securing a mortgage with the lowest interest rates and best terms. If your score is just “good” or between 670 and 739, on the other hand, you may also qualify for the best mortgage rates or get pretty close but you’re not a shoe-in by any means.

Individuals with “fair” or “poor” credit, on the other hand, may struggle to get a mortgage with the best rates or to qualify for a conventional mortgage at all. Certain mortgages offered through the federal government, such as FHA loans, may let you get a mortgage with a score as low as 580, however.

If you’re curious about your credit score, the best thing you can do now is find out where you stand. Fortunately, websites like Credit Karma and Credit Sesame will let you see an estimate of your credit score after signing up for a free account.

Your Down Payment

In terms of your down payment, how much you’ll need to save depends on the type of home loan you apply for. FHA loans may be offered to consumers with down payments as low as 3.5%. If you want to secure a conventional home loan, you typically need to save up at least 3% to 5%.

Still, you should try to save up at least 20% of your home’s purchase price before you take out a mortgage. Doing so will help you avoid having to pay for PMI, or private mortgage insurance. PMI can layer on an additional .5% to 1% of your home’s purchase price onto your payments each year. In other words, if you take out a home mortgage for $100,000 and put less than 20% down, your PMI payments could be as much as $1,000 per year.

Your Employment History

While your individual situation will be assessed by your lender, all lenders like to see a solid history of employment before they will lend you money. It helps to have two years of employment history with the same employer, although your lender may accept it if you recently switched employers but remained gainfully employed.

You will also need to submit recent pay stubs during the mortgage application process, so keep that in mind.

How Much Home Can You Afford?

Of course, you won’t qualify for an open-ended mortgage for any type of home. How much you can afford to borrow is determined using a wide range of factors such as your income and how much debt you have. Generally speaking, lenders prefer to lend money to people whose debt-to-income ratio is less than 43 percent including housing costs. Many lenders also set the maximum debt-to-income ratio for your mortgage at 36 percent.

What does this mean? If you earn $100,000 per year (grossing $8,333 per month), your total debts should cost less than $43,000 per year or $3,583.33 per month. Your mortgage payments should be less than 36 percent of your income, or $36,000 per year and $3,000 per month. Also keep in mind that it’s not only the P&I (principal and interest) of your mortgage that will count toward this percentage; other components of your mortgage matter too, including items paid via escrow such as property taxes, PMI, and insurance.

Lenders use the debt-to-income ratio to make sure you aren’t overspending on a house you cannot afford after accounting for your other bills. If you’re curious how much how you can afford based on your debt load and income, we’d suggest playing around with a mortgage calculator that will give you a good idea of where you stand.

The Mortgage Application Process

Once you have a good idea of your credit score and how much you can afford to spend, you can move on to the next stage of buying a home — qualifying for a mortgage. While you can wait until you find a home to buy to get qualified, most experts suggest you get prequalified before you shop for a home. With a prequalification letter from a lender, you’ll have the best chance at getting the home you want and beating out other buyers who may make offers at the same time as you do.

Applying for a mortgage is easy, but new technology has made it even easier to compare rates. Many websites like LendingTree let you compare multiple mortgage offers from several lenders in one place while only having to submit your information once.

Speaking of information, you’ll need to gather quite a bit of personal information before you apply for a home loan. Information you’ll need to gather includes:

  • Paystubs from the last 30 days
  • W-2 forms from the last two years
  • Information on all your debts including car loans and student loans
  • Recent bank statements from all your accounts
  • Tax returns from the last two years
  • Proof of any supplemental income you have

Once you gather this paperwork, you can apply for a mortgage with a mortgage broker, your local bank, or online. Make sure to compare lenders and offers to ensure you’re getting the best rate and terms for your needs.

Types of Mortgages Available

Finally, you’ll have to choose the type of mortgage you want for your new home. While there’s no “right” or “wrong” mortgage, there are several types to consider with their own pros and cons. Mortgages that may be offered to you include:

  • Conventional Mortgages: Conventional mortgages are loans that are not insured by the federal government. These loans typically require good or decent credit and come with the lowest rates and best terms.
  • Fixed-rate Mortgages: Conventional home loans can come with fixed interest rates if you choose, meaning your interest rate and monthly payment (P&I) will stay the same throughout the life of your loan.
  • Adjustable-rate Mortgages: If you prefer an adjustable rate that goes up and down based on the prime rate, you may qualify for a conventional home loan that fits the bill. These loans come with lower interest rates when rates are low, but your rate and payment isn’t guaranteed and could surge if interest rates rise.
  • FHA Loans: FHA loans are offered through private lenders but insured and regulated by the federal government. These loans accept borrowers with poor or fair credit and tend to come with low interest rates.
  • VA Home Loans: VA loans are government-backed loans offered to veterans from the U.S. Armed Forces, active duty military, and their spouses. These loans may come with looser credit and down payment requirements and lower interest rates.
  • USDA Loans: The U.S. Department of Agriculture and Rural Development offers its own home loan program for rural properties. These loans come with low interest rates and may be easier to qualify for if you’re buying a rural home and can’t qualify for a conventional mortgage.